Debt Consolidation

Debt consolidation means taking one loan to pay off many other loans. Debt consolidation is often used to secure a lower interest rate, have a fixed rate of interest or for the convenience of servicing just one loan.

Debt consolidation, simply said, can be moving from a number of unsecured debts to another single unsecured debt. However, debt consolidation loans are often taken as secured loans. Secured loans come at lower interest rates than non-secured loans. It makes good sense to get a loan at a lower interest to pay all other high interest loans, but the low interest loan often requires an asset that acts as collateral, which most commonly would be a house. A mortgage is secured against the house, and the asset owner agrees to allow forced sale of the asset to pay back the loan. The risk to the lender is minimized so the interest rate offered is lower.

If the debtor is faced with bankruptcy, debt consolidation companies will buy the loan at a discount. A sensible debtor can shop around for debt consolidation companies that are willing to share some of the savings. Debt consolidation can have an effect on the debtor’s ability to discharge his debts in bankruptcy; hence the decision to consolidate must be weighed carefully.

In theory, debt consolidation is most suited if the debtor is looking to pay credit card debts. Credit cards often carry a much larger interest rate than even the expensive non-secure loans. Debtors with property can get secured loans at a much lower interest rate by using the property as collateral. With a low interest and less money spent on debt servicing the loan can be paid off much sooner. What is said in theory is a little bit different to reality. Why people fall into increased credit card debt is because they cannot limit their spending to what they earn. This practice if continued will make loan consolidation a waste with assets like the house at stake.

Because of this theoretical advantage of debt consolidation for debtors, debt consolidation companies can charge exorbitant fees to take advantage of that benefit.  Sometimes these fees are near the maximum amount allowed by law. Some unscrupulous companies will knowingly wait until the client has no other choice but to refinance and consolidate to tell them that they are behind their loan payments. In some cases the client might not have enough time to shop for another lender with lower fees and may not even be fully aware of them. This practice is known as predatory lending. Most, debt consolidation transactions do not involve predatory lending.